Investor Class Actions Seen at Risk in Halliburton CaseGreg Stohr
A quarter-century after the U.S. Supreme Court opened the era of class action shareholder litigation, the justices may be poised to shut it down.
The court will hear arguments March 5 on a Halliburton Co. appeal targeting the legal doctrine that underlies the vast majority of securities-fraud class actions. Backed by business groups, Halliburton is seeking to overturn a landmark 1988 Supreme Court ruling that four of the nine justices have already called into question.
Should the court take that step “then this is huge,” said Jeffrey Mahoney, general counsel of the Council of Institutional Investors, which is urging the court to reaffirm the 1988 ruling, as is the Obama administration. “No matter which side you are on, whether you like it or hate it, it’s huge.”
Securities-fraud cases have become an industry unto themselves even as Congress has tried to rein them in. More than 4,000 class-action suits have been filed since 1996, producing almost $80 billion in settlements, according to Nera Economic Consulting, a unit of insurance broker Marsh & McClennan Cos.
Accords involving Enron Corp. and WorldCom Inc. alone totaled more than $13 billion, and Bank of America Corp. last year agreed to pay $2.4 billion to settle investor claims over its Merrill Lynch & Co. acquisition. Pfizer Inc., Vivendi SA and Amgen Inc. are among the companies with pending lawsuits that could be affected by the high court case.
The litigation explosion stems from the 1988 Basic v. Levinson ruling. That decision said judges considering misrepresentation claims should presume that investors will take any public misstatement into account before buying shares.
That “fraud-on-the-market presumption” helps shareholders overcome two separate legal hurdles: the securities-law requirement that they show they relied on a company misstatement and the class-action requirement that the plaintiffs’ claims have enough similarities to warrant a group lawsuit.
Without the presumption, each shareholder would have to show individual reliance on an alleged misstatement. That requirement, in turn, would preclude class actions because it would require judges to conduct a case-by-base inquiry into the circumstances of each shareholder.
“Basic is the watershed event in securities class actions,” said Adam Pritchard, a securities law professor at the University of Michigan Law School. “It makes the modern securities class action industrial complex possible.”
The idea behind the Basic ruling was that the securities markets operate efficiently. As Justice Ruth Bader Ginsburg wrote last year, the “premise is that the price of a security traded in an efficient market will reflect all publicly available information about a company.”
Halliburton says experience and research have shown the market to be much less efficient than the court thought. The company cites a litany of examples, including the 1998-2001 technology bubble and the “Black Monday” stock crash in October 1987, when the Dow Jones Industrial Average plummeted 23 percent.
“Basic’s presumption of reliance cannot coexist with the reality that where one would expect maximum market efficiency and rationality, markets can prove extraordinarily inefficient and irrational,” Halliburton argued in court papers.
David Boies, the attorney representing the shareholders, said those anomalies don’t undermine the general rule that securities prices incorporate public information reasonably promptly. He noted that the court heard arguments in Basic two weeks after the Black Monday crash.
“Irrespective of other forces that may move the markets at times, the court simply concluded that ‘most publicly available information is reflected in market price,’” Boies argued in court papers, quoting from the Basic ruling.
He said overruling Basic “would mean the demise of private securities actions and the deterrent and compensatory role they serve.”
The shareholders, led by the Erica P. John Fund, contend that from 1999 to 2001 Houston-based Halliburton falsified earnings reports, played down estimated asbestos liability and overstated the benefits of a merger.
Dick Cheney, later the U.S. vice president, served as chairman and chief executive officer of the oilfield-services provider during part of the disputed period.
Joseph Grundfest, a former Securities and Exchange Commission member who now teaches at Stanford University’s law school, said investors would retain protections without the Basic precedent. The SEC and Justice Department would keep their authority, and investors could still sue over misleading registration statements under a different provision in the securities laws, he said.
In addition, institutional investors would be able to press fraud suits outside the class action context if they could show they relied on a misstatement.
“If you have frauds that are sufficiently large and you have investors that have sufficiently large positions in those companies, it will make sense for those investors to bring individual actions,” Grundfest said.
Doing so would require many institutional investors to change the way they operate, Mahoney said. Many of his group’s members -- pension funds, endowments and foundations, collectively with more than $3 trillion in assets -- rely on passive strategies like indexing, so they don’t spend time and money analyzing company statements.
“That will make it difficult for them to be able to demonstrate reliance because they didn’t actually dig through all the information from the company,” Mahoney said. “Instead, they just invest in an index.”
The Basic decision produced a highly usual vote -- 4-2, with three of the nine justices recusing themselves.
Four current justices -- Antonin Scalia, Clarence Thomas, Anthony Kennedy and Samuel Alito -- suggested in a ruling last year that they might overrule Basic. The outcome may be in the hands of Chief Justice John Roberts, who usually joins that group in ideologically divisive cases.
“He’s kind of the decider,” said Tom Goldstein, a Washington lawyer who represents plaintiffs in securities suits. He said Roberts takes an “institutional long view” of the law that might make him reluctant to discard the Basic precedent.
Investor advocates and the Obama administration say the Basic presumption helps protect shareholders from company fraud.
Class actions “are an essential supplement to criminal prosecutions and civil enforcement actions” by the government, U.S. Solicitor General Donald Verrilli told the justices in court papers.
Some securities experts say the cost isn’t worth it. Pritchard says that about 40 percent of the money that changes hands in securities cases ends up with the lawyers.
“In its current state, we’re spending too much to get the deterrent benefits that we receive,” he said.
The court will rule by July in the case, Halliburton v. Erica P. John Fund, 13-317.